The Novelty of Innovation: Competition, Disruption, and Antitrust Policy

Innovation is not just a matter of doing things better. It is also a matter of doing things differently. We develop a model to capture the novelty of innovation and explore what it means for the nature of market competition and quality of innovations. We show that a variant of the famed Arrow replacement effect holds in that new entrants pursue more innovative technologies than do incumbents. This result is reversed, however, when the incumbent can acquire the entrant post-innovation. The prospect of acquisition makes innovation more profitable but simultaneously suppresses the novelty of innovation as the entrant seeks to maximize her value to the incumbent. This reversal suggests a positive role for a strict antitrust policy that spurs entrepreneurial firms to innovate boldly. The model also yields new insight into the nature of competition in innovative industries, when disruption occurs, and why firms acquire competitors only to shut them down.